Prediction: Election Day Will Represent an Ominous Turning Point for Wall Street

In just three days, Americans will head to the polls or mail in their ballots to determine which presidential candidate -- current vice president and Democratic presidential nominee Kamala Harris, or former president and Republican presidential nominee Donald Trump -- will lead our great nation over the next four years.

Considering that all three major stock market indexes, the ageless Dow Jones Industrial Average (DJINDICES: ^DJI), broad-based S&P 500 (SNPINDEX: ^GSPC), and growth-stock-propelled Nasdaq Composite (NASDAQINDEX: ^IXIC), have ascended to multiple record highs in 2024, all eyes are on this highly contested presidential race.

While each candidate brings unanswered questions to the table (and it's no secret that Wall Street dislikes uncertainty), a potentially bigger issue looms larger for stocks.

Vice president and Democratic presidential nominee Kamala Harris speaking with reporters. Image source: Official White House Photo by Lawrence Jackson.

Investors weigh uncertainties for each presidential candidate

Let me preface this discussion by pointing out that campaign promises aren't always put into action. If the winner on Nov. 5 faces a divided Congress, it's unlikely they'll be able to implement many of the policies they've proposed while on the campaign trail.

With the above being said, there are proposals on both sides of the political aisle that are cause for concern on Wall Street.

For example, Harris has proposed tackling America's rapidly rising national debt by increasing taxation on select groups. More specifically, Harris wants to quadruple the share buyback tax for public companies from 1% to 4%, increase the ordinary capital gains tax from 20% to 28%, and lift the peak corporate tax rate by a third, from a historically low 21% to 28%.

While all of these actions would raise federal revenue, they also have the potential to adversely impact the stock market. Buybacks have been an especially useful tool America's biggest publicly traded companies have used to reward investors and boost their earnings per share (EPS). Apple has reduced its outstanding share count by more than 42% since the start of 2013, which has had a notably positive impact on its EPS.

Meanwhile, Trump wants to impose tariffs on U.S. imports as a way of encouraging domestic production. Tariffs for Chinese products imported into the U.S. would hit 60%, with a 20% tariff on imports from other countries, according to Trump.

The problem with tariffs is they have the potential to spark a trade war, which can increase prices domestically and hamper supply chains. Tariffs can be a mixed bag when it comes to corporate profits.

While there are undeniable question marks for Wall Street, there's a much bigger concern for stocks that transcends Election Day.

Image source: Getty Images.

Moving past Election Day will put the focus back on Wall Street's biggest problem

Even with the possibility of a few states not having complete election data available on Nov. 5, America will know relatively soon thereafter whether Kamala Harris or Donald Trump will be the next president. Once this big question is answered, investors are going to, once again, turn their attention to Wall Street's glaring problem: its historically high valuation.

There are a lot of metrics that help investors determine whether a stock is cheap or pricey, relative to its peers and the broader market. The most well known of these tools is the price-to-earnings (P/E) ratio, which divides a company's share price into its trailing-12-month EPS.

While the traditional P/E ratio has its uses, there's another valuation tool that provides a comprehensive look at broader-market valuations dating back more than 150 years. This metric is the S&P 500's Shiller price-to-earnings ratio, which is also known as the cyclically adjusted price-to-earnings ratio (CAPE ratio).

The Shiller P/E is based on average inflation-adjusted EPS from the previous 10 years. Whereas the traditional P/E can be flummoxed by one-off events, such as lockdowns during the COVID-19 pandemic, the Shiller P/E does an excellent job of smoothing out these shock events to create apples-to-apples comparisons.

As of the closing bell on Oct. 30, the S&P 500's Shiller P/E was 37.05, which is more than double its all-time average of 17.17, when back-tested to January 1871. This also represents the third-highest reading during a continuous bull market in history.

S&P 500 Shiller CAPE Ratio data by YCharts.

History has been extremely unkind to the Dow Jones, S&P 500, and Nasdaq Composite following the few prior occurrences when the Shiller P/E surpassed 30. Including the present, topping a reading of 30 during a bull market has only happened six times in 153 years. The five previous instances all resulted in losses ranging from 20% to 89% for Wall Street's major stock indexes.

The caveat to the Shiller P/E is that it's not a timing tool. Valuations can remain extended for a few weeks, as they did prior to the COVID-19 crash, or multiple years, as we witnessed prior to the dot-com bubble bursting. However, this metric clearly shows that premium valuations are unsustainable over long periods.

Thus, Election Day may represent an ominous turning point for Wall Street.

Patience is handsomely rewarded on Wall Street

While select forecasting tools and valuation metrics suggest the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite are each headed for a meaningful correction, history also has something positive to offer patient investors.

Every year, the analysts at Crestmont Research update a published data set that calculates the rolling 20-year total returns, including dividends paid, of the broad-based S&P 500. Even though the S&P didn't come into existence until 1923, researchers were able to track the performance of its components in other indexes dating back to 1900. Thus, Crestmont was able to gauge the total return performance of the S&P 500 over 105 separate rolling 20-year periods (1919-2023).

What Crestmont Research's data set shows is that all 105 rolling 20-year periods produced a positive total return. In fact, more than 50 of these periods generated an annualized return of at least 9%. Put in another context, if you, hypothetically, purchased an S&P 500 tracking index at any point since 1900 and held it for 20 years, you would have made money every single time.

Regardless of who was elected president, which political party was in power, or how pricey or cheap Wall Street was perceived to be, patience has been consistently rewarded on Wall Street.

This isn't the only data set that confirms how much of an ally time can be for investors, either.

It's official. A new bull market is confirmed.

The S&P 500 is now up 20% from its 10/12/22 closing low. The prior bear market saw the index fall 25.4% over 282 days.

Read more at https://t.co/H4p1RcpfIn. pic.twitter.com/tnRz1wdonp

-- Bespoke (@bespokeinvest) June 8, 2023

In June 2023, the analysts at Bespoke Investment Group published a data set on X, the social media site formerly known as Twitter, which examined the calendar-day length of 27 separate bear and bull markets in the S&P 500 since the start of the Great Depression in September 1929.

According to Bespoke's calculations, the average S&P 500 bear market has lasted 286 calendar days, while the typical bull market has endured for 1,011 calendar days. To boot, 14 out of 27 bull markets have stuck around longer than the lengthiest S&P 500 bear market on record.

Regardless of what predictive metrics suggest can happen over the short run, time and history continue to be in the corner of long-term-minded investors.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple. The Motley Fool has a disclosure policy.